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- 1. Financial Analysis Using the financial statements from the Major Medical Center Case Study below, analyze the following: x Review the auditor’s opinion letter and analyze any concerns. x Review the financial statements. Analyze any unusual items and examine the balance sheet, operating statement, and cash flow statement. x Review the notes and analyze any causes for concern. x Calculate the following ratios using Excel: common size, current, quick, days of cash on hand, receivables turnover, average collection period, fixed asset turnover, total asset turnover, debt, debt to equity, timesͲinterestͲearned, operating margin, total margin, Return On Assets (ROA), and Return On Net Assets (RONA). x Evaluate Major Medical Center’s financial status. Submit fourͲpage Word document (not including the title and reference pages) and an Excel worksheet. Paper need to be formatted to APA style, and must cite at least four scholarly sources. 552 Part VI • Financial Analysis
- 2. Case Study Problem 15-12. For the Major Medical Center financial statements on the following pages, complete the following: a. Read the auditor's opinion letter. Are any flags raised? b. Review the financial statements. Search for un- usual items. What things catch your eye on the balance sheet, operating statement, and cash flow statement? c. Review the notes. Do any of them raise cause for concern? d. Calculate the following ratios: common size, cur- rent, quick, days of cash on hand, receivables turnover, average collection period, fixed asset turnover, total asset turnover. debt, debt to equity. times-interest-earned, operating ma rgin, total mar- gin, ROA, and RONA. e. What do you think of Major Medical Center's financial sta t us? CASE STUDY Major Medical Center8 I.N. SINGER AND OW, GPAs 2650 East 38th Street New York, New York 10089 Report of Independent Auditors Board of Trustees Major Medical Center
- 3. We have audited the accompanying statements of financial position of Major Medical Center (the "Medical Center") as of December 31, 2014 and 2013, and the related statements of operations, changes in net assets, and cash flows for the years then ended. These financial statements are the responsibility of the Medical Center's management. Our responsi bility is to express an opinion on tl1ese financial state- ments based on our audits. We conducted our a udits in accordance with generally accepted aud iting stan- dards. Those standards require that we plan and perform the audit to obtain rea- sonable assurance about whether t11e financial statements are f ree of material mis- statement. An audit includes examining, on a test basis, evidence suppotting the amounts and disclosures i n the financial statements. An audit also includes assess- ing the accounting principles used and significant estimates made by management, as well as evaluating the overall fina ncial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Major Medical Center at December 31, 2014 and 2013, and tl1e results of its operations, changes in net assets, and cash flows for the years then ended, in conformity with generally accepted accounting principles. April 30, 2015 i.N. SINGER AND OLD, CPAS RMajor MedicalCenter and Ho pital Support, Inc. are llctional organizations. Any similarity to r al organizations is purely coincidental.
- 4. Chapter 1'5 • Financial Statement Analysis 553 Major Medical Center Statements of Financial Position Assets Current Assets Cash and cash equivalents Assets limited as to use-compensating balance for letters of credit Short-term investments Receivables for patient care, net of allowance for doubtful accounts (2014-$27,232; 2013-$31,934) Pledges receivable Inventories, at average cost Due from third-party reimbursement programs Receivables for government grants Other Total Current Assets Assets Limited as to Use Sinking fund Compensating balance for standby letters of credit Long-term investments Due from affiliates, net Pledges receivable, net of allowance for uncollectible pledges (2014-$2,218; 2013-$4,453) Property, plant, and equipment net
- 5. Deferred financing costs Other Liabilities and Net Assets Current Liabilities Current portion of long-term debt Accounts payable and accrued expenses Accrued salaries and related liabilities Due to third-party reimbursement programs, net Advances on government grants Total Current Liabilities Long-term debt, less current portion Accrued post-retirement benefits Other noncurrent liabilities Total Liabilities Commitments and contingencies Net Assets Unrestricted Temporarily restricted Permanently restricted TotalNet Assets Total Liabilities and Net Assets Scl' an'Ompanying note . December 31 2014 2013 (In Thousands) $ 8,065 $ 9,005 1,000 1,387 1,283 49,719 47,614 1,814 2,205 1,690 2,326 6,539 467
- 6. 2,234 3,415 $ 72,448 $ 66,315 14,487 13,410 923 1,132 618 3,417 3,543 1,889 1,468 98,555 89,777 1,323 2,065 1,043 $196,239 $176,174 $ 11,608 $ 11,488 29,489 25,311 25,572 20,096 1 ,874 1,587 $ 68,256 $ 58,769 55,539 47,709 6,023 6,017 16,445 17,014 $146,263 $129,509 $ 40,582 $ 38,014 8,262 7,519 1'132 1 '132 $ 49,976 $ 46,665 $196,239 $176,174
- 7. 554 Part VI • Finandal Analysis Major Medical Center Statements of Operations Year ended December 31 2014 2013 (In Thousands) Operating Revenue Net patient service revenue $402,921 $369,512 Other revenue 13,356 13,850 Net assets released from restrictions 4,708 2,863 Total Operating Revenue $420,985 $386,225 Operating Expenses Salaries and wages $207,141 $196,453 Employee benefits
- 8. 44,456 44,860 Supplies and expenses 137,505 117,838 Depreciation and amortization 22,541 18,856 Research 2,457 2,214 Interest 4.456 5,253 Total Operating Expenses $418,556 $385,474 Operating Income $ 2,429 $ 751 Net assets released from restrictions used for capital acquisitions 139 146 Increase in unrestricted net assets $ 2,568 $ 897
- 9. Sec accompanying notes. Major Medical Center Statements of Changes in Net Assets Net Assets Temporarily Permanently Unrestricted Restricted Restricted (In Thousands) Net Assets at December 31, 2012 Increase in unrestricted net assets Restricted contributions, grants, and other receipts Investment income restricted for specific purposes Net assets released from restrictions for: Operating expenses Capital asset acquisitions Change in net assets Net Assets at December 37, 2013 $37,117 $ 897 $ 897 $38,014
- 10. $3,023 -$- 7,253 252 (2,863) (146) $4,496 $7,519 $1,132 -$- -$- $1,132 Increase in unrestricted net assets Restricted contributions, grants, and other receipts Investment income restricted for specific purposes Net assets released from restrictions for: Operating expenses Capital asset acquisitions $ 2,568 -$--$ - 5,421 169 (4,708) (139) Change in net assets Net Assets on December 31, 2014
- 11. $ 2,568 $40,582 $ 743 $8,262 $ $1,132 See accompanying notes. Chapter 15 • Financial Statement Analysis 555 Major Medical Center Statements of Cash Flows Year Ended December 31 ( Operatin g Activities Operatin g income $ 2,429 $
- 14. income earned on asset s limite d as t o use (774) (698) Changes in operatin g asset s and lia b
- 27. See accompanyin g notes. )2014 2013 (In Thousands)
- 28. Notes to Financial Statements 1. Organization and Summaty of Significant Accou nti ng Policies Orgattizatiotz Major Medical Center (the "Medical Center") is a not-for-profit corporation. The Medical Center provides health care and related services. The accompanying financial statements do not include the accounts of the Research Foundation, a not-for- profit corporation that solicits funds and awards grants to the Medica l Center for research purposes, nor for Hospital Support, Inc., which provides certain su pport services. Temporarily and Permanently Restricted Net Assets Temporarily restricted net assets are those whose use by the Medical Center has been limited by donors to a speci fic time period or purpose. Permanently restricted net assets 556 Part Vl • Financial Analysis have been restricted by donors to be maintained by the Medical Center in perpetuity. When a donor restriction expires (i.e., when a stipulated time restriction ends or pur- pose restriction is accomplished), temporarily restricted net assets are reclassified as un- restricted net assets and reponed in the statements of operations as net assets released from restrictions. Donor-restricted contributions whose restrictions
- 29. are met within the same year as received arc reflected as tempora rily restricted contributions and net asset<; released from restrictions in the accompanying financial statements. Receivables for Patiettt Care Patient accounts receivable from th i rd-pa rt y programs for which the Medical Center receives payment under reimbursement formulas or negotiated rates are stated at the estimated net amounts receivable from such payors, which are generally less than the established charges of the Medical Center. Investments Investments consist of U.S. Treaswy bonds and notes, certificates of deposit, and money mar- ket funds. Investments arc carried at fair value. Amounts classilled as long-term investments, consisting primarily of money market funds, represent pem1anently n:suicted net assets. lnvestmetzt Gains, Losses, and Income Investment income, which includes real gains and losses, earned on permanently re- stricted and temporarily restricted funds upon which restrictions have been placed by donors, is added to temporarily restricted funds. All other investment income is ret1ectecl in the accompanying statement'> of operations. Property, Plant, and Equipment Propetty, plant, and equipment purchased are canied at cost, and mose acquired by gifts and bequests are carried at appr'dised or fair ma rket value established at the date of acquisition. Capitalized leases are recorded at the fair market value at the inception of the leases. l11e canying amounts of assel<; and the related accumulated depreciation are removed from the accounts when such assets are disposed of, and any resulting gain or loss is included in oper- ations. Depreciation of assets used in
- 30. operations is recorded on me stra ight-line method over the estimated useful lives of tl1e asset<;. Capit.'llized leases are amortized over the lease tem1. Pledges Unconditional promises to give cash and other assets are repotted at their net present value at the date the promise is received. The gifts are reported as either temporarily or permanently restricted support if they are received with donor stipulations that limit the use of the donated assets. Pledges receivable, discounted at 10 percent, are expected to be paid as follows (in thousands): Less than one year $ 1,814 One year to five years 3,145 In excess of five years 962 $ 5,921 Less allowance for uncollectible pledges receivable (2,218) $ 3,703 Assets Limited as to Use Assets classified as limited as to use represent assets whose use is restricted for specific purposes under terms of agreement'S.
- 31. ---- ----- - - --- Accrued Post-Reliremellt Benefit s Chapter 15 • Financial Statement Analysis 557 The itedical Center account<> for post-retirement health care and life insurance benefits on the accrual basis of accounting. Uucompe11sated Care As a matter of policy, the Medical Center provides significant amounts of partially or totally uncompensated patient care. For accounting purposes, such uncompensated care is treated either as charity care or bad debt expense. The Medical Center has defined char- ity care for accounting and disclosure purposes as the difference between its customary charges and the sliding scale rates given to patients in need of financial assistance. Since payment of this difference is not sought, charity care allowances are not repotted as reve- nue. Patients who do not qualify for sliding scale fees and all uninsured inpatient<; who do not qualify for Medicaid assistance arc bi lled at the Medical Center's full rates. Uncollected balances for these patients are categorized as bad debts. Total uncompensated care for all patient services approximated $22 million and $20 million in 2011 and 2013, respectively.
- 32. Use of Estimates The preparation of financial statements in conformity with generally accepted account- ing principles requires management to m:.tke estimates and assumptions that affect the reported amount of assets and liabilities and the d isclosure of contingent assets and liabilities at the date of the financial statements. Estimates also affect the reported amoums of revenue and expenses during the reponing period. Actual results could differ from these estimates. Management believes that the amounts recorded based on estimates and assumptions are reasonable, and any differences between estimates and actual should not ha e a material impact on the Medical Center's financial position. Operatbzg Income Transactions deemed hy management to he ongoing, major, or central to the provision of health care services are reported as operating revenue and expenses, and arc included in operating income. Operating income also includes investment income and realized gains and lossl's from the sale of investments. Tax Status The tvll'dical Center is exempt from federal income taxes under Section '501(c)(3) of the Intl'rnal Revenue Code. The Medical Center has been classified as an organization that is not a private foundation under Section 509(a)(1 ). Contributions received by the Medical Cl'nter qualify as tax-deductible charitable contributions. 2. Third-Party Reimbursement Programs Tlw tledical Center has agreements with third-party payers
- 33. that provide for payments to tlw Medical Center at amounts different from its established charges. Payment ar- rangements include prospectively determined rates per discharge, reimbursement of costs, discounted charges, and per diem payments. Patient service revenue is recorded at the Medical Center's established charges when patient services are performed. Adjustments for differences between established charges and payment amounts are deducted directly from receivables for patient care and patient service revenue in the year incurred. Federal and state regulations provide for certain retrospective adjustments to cun·ent and ptior years' payment rates based on industrywide and hospital-specific data. The Medical Center has estimared the potential impa<.1of such retrospective adjustments based on infOtma- rion presently available, and adjustments are accrued on an estimated basis in the period the setvices are rendered and are adjusted in future peti<xls as final seulements are determined. 558 Part VI • Financial Analysis Management believes that amounts recorded in the accompanying financial statements will not be materially affected upon the final settlement of such retrospective adjustments. Hospitals are reimbursed for Medicare inpatient services under the national pro- spective payment system ("PPS") and other methodologies of the Medicare program for patient services. Such Medicare payments are based on a blend of national industry and hospital- specific data. The Medicaid program pays rates determined by the state, primar- ily on a basis of prospectively determined rates per discharge. The Medical Center is paid by non- Medicare/Medicaid payers based on negotiated contract amounts or, if such contracts do not exist, at the Medical Center's established charges. In addition, the state has
- 34. requested a waiver from the federal government that will allow it to enroll substan- tially all of its Medicaid patticipants into Medicaid managed care programs. The ultimate outcome and effect of these changes and proposals on the Medical Center's future op- erations cannot presently be determined. In 2014, net revenue from the Medicare and Medicaid programs accounted for 44 percent and 23 percent, respectively, of total net patient service revenue. 3. Assets Limited as to Usc A summary of assets limited as to use is as follows at December 31: 2014 2013 Sinking Funds: (In Thousands) Cash and cash equivalents U.S. government and agency obligations Total Sinking Funds Collateral for Standby Letters of Credit: Cash and cash equivalents Corporate bonds Total Collateral for Standby Letters of Credit Total Assets Limited as to Use $ 276 14,211 $14,487 $ 582
- 35. 1,341 $ 1,923 $16,410 $ 249 13,161 $13,410 $ $ $13,410 4. Property, Plant, and Equipment A summary of property, plant, and equipment is as follows at December 31: 2014 2013 (In Thousands) Land $ 4,980 $ 4,980 Buildings 58,827 58,827 Equipment 164,592 140,707 $228,399 $204,514 Less accumulated depreciation
- 36. 141,502 125,148 $ 86,897 $ 79,366 Projects in progress 11,658 10,411 $ 98,555 $ 89,777 Approximately $45,673,000 and $45,706,000 of fully depreciated asseL'i are included in buildings and equipment at December 31, 2014 and 2013, respectively. Substantially all prop- erty, plant, and equipment is pledged as collateral under various loan agreements. Capitalized equipment leases, included in property, plant, and equipment, are as follows at December 31: --- --- -- ----- -- - Chapter 15 • Financial Statement Analysis 559 2014 2013 Assets recorded under capital leases (In Thousands)
- 37. $67,434 $51,695 Less accumulated amortization 35,911 $31,523 27,108 $24,587 5. Long-Term Debt A summary of long-term debt is as follows at December 31: 2014 2013 FHA Section 242 insured mortgage loan (a) FHA Section 241 (In Thousands) $20,865 $ mortgage loan (a) 10,941 12,125 2005 mortgage loan (b) 2,216 2,758 1998 insured mortgage loan (a)
- 38. Various mortgages, having interest rates ranging from 3.5% to 10.0%, maturing at various dates through 2021 Capitalized leases (c) Less current portion 2,020 31,105 $67,147 11,608 $55,539 15,492 2,892 25,930 $59,197 11,488 $47,709 a. As a condition of these borrowings, the Medica l Center is required to establish and maintain a sink ing fund. Amounts deposited into the sinking fund, to- gether with investment earnings therein, arc ava ilable for principal payments and purchases of specified levels of capita l assets. Assets on deposit in the sinking fund at December 31, 2014 and 201.3, are in compliance with there- quired amounts. b. Annual principal payments for all long-term debt, excluding capital leases and requi red sinking fund balances for
- 39. the next five yea rs, are as follows: Principal Payments Required Sinking Fund Balance (In Thousands) 2015 $2,789 $15,461 2016 4,688 14,937 2017 4,157 14,162 2018 4,089 13,129 2019 3,746 11,831 c. Future minimum payments, by year and in the aggregate, under capitalized leases consisted of the following at December 31, 201 4 (in thousands): 560 Pan VI • financial Analysis 2015
- 40. $11,102 2016 9,852 2017 8,204 2018 4,744 2019 1,518 Thereafter 850 Total minimum lease payments $36,270 Less amounts representing interest (5,165) Present value of lease payments $31,105 6. Retirement and Similar Benefits The Medical Center provides retirement and similar benefits to its union employees through several defined benefit multi-employer pension plans and to its nonunion em- ployees through a noncontributoty defined benefit pension plan and tax-deferred annuity plans. Payments to the defined benefit multi-employer union plans arc made in accor- dance with contractual arrangements under which contributions are generally based on gross salaries and arc funded on a current basis. The Medical Center contributes amounts to the nonunion plan sufficient to meet the minimum funding requirements set fotth in the Employee Retirement Income Security Act of 1974. The Medical Center's pension ex- pense under all existing plans aggregated approximately 510,202.000 and S10,6R:),OOO for the years ended December 31, 201"1 and 2013, respectively.
- 41. 7. Other Post-Retirement Benefits In addition to the pension plans and the tax-sheltered annuity plans described in "ote 6, the Medical Center sponsors a defined benefit health care plan that provides post-retirement medical, dental, and life insurance benefits to cettain full- time employees hired prior to July I, 200!, and who have worked 10 years and attained age 65 while in service with the Medical Center. The plan contains cost-shating features such as deductibles and coinsurance. Effective in May 2014, the Medical Center changed the type of the plan from basic hos- pital plus major medical to a point-of- service plan for nonunion employees. ·n1e effects of this change have been reflected in the actuary's calculation for the plan year ended December 31. 2014. At the end of 201·1 and 2013, the accrued post- retirement benefit cost was $6,02:).000 and $6,017,000, respectively. As of December 31, 201"1 and 2013. the plan was unfunded. 8. Government Crants The Medical Center receives grants from various government agencies. For the contract years ending June 30 , 2015, 2016, and 2017, these grant awards are as follows: Contract Year Ending June 30: 2015 2016 2017 Amount (In Thousands) $3.791 3,513
- 42. 3.765 Advances on government grants of $1,587,000 at December 31, 2011, as reflected in the accompanying statement of finaacial position, represent amounts received from the granting agencies in excess of claims made at that date. The receivable amount of $467,000 at December 31, 2013, represents claims made in excess of advances recei'ed from the granting agencies at that date. 9. Professional Liabil ity Insurance The Medical Center patticipates in a pooled program with cettain other health care facili- ties (principally medical centers) for professional liability insurance. This p uticipation is Chapter 15 • Financial Statement Analysis 561 with captive insurance companies and, with the other health care facilities, in a pooled layer for additional insurance with commercial insurance companies. During 2013, the Medical Center had an aggregate deposit of $2,000,000 with two of the captive insurance companies. During 2014, these deposits were replaced with two letters of credit of $1,000,000 each. The deposits were included in other current assets in the accompanying 2013 statement of financial position.
- 43. Malpractice claims in excess of insurance coverage have been asserted against the Medical Center by various claimants. The claims arc in various stages of processing, and some may ultimately be brought to trial. Medical Center management and counsel arc unable to conclude about the ultimate outcome of the actions. There are known inci- dents occurring through December 31, 2014, that may result in the assertion of additional claims, and other claims may be asserted arising from services provided to patients in the past. It is the opinion of Medical Center management, based on prior experience, that adequate insurance is maintained to cover all significant professional liability losses. 10. Transactions with Affiliates The amounts due from affiliates in the accompanying statements of financial position at D<.:cemher 31, 2014 and 2013, include a $1,900,000 loan receivable and accrued interest thereon from Hospital Support, Inc. The loan, which does not have specified repayment terms, bears interest at the prime rate, which approximated 7.7) percent at December 31, 2011 and 2013. 11. Tempor..trily and Permanently Hestricted Net Assets TL·mporarily restricted net assets are available for the following purposes at December 31: 2014 2013 (In Thousands)
- 44. Research and education $2,502 Plant replacement and expansion 5,017 $7,519 Permanently restricted net assets at both December 31, 2014 and 2013, consist of investments to be held in perpetuity and whose income is restricted as to use. 12. Other Operating Revenue Other operating revenue consisted of the following for the year ended December 31: 2014 2013 (In Thousands) Government grant income Real estate rentals Investment income and gains on sale of investments Faculty practice and research overhead Dining room and parking $ 1,668 2,838 1,077 5,703
- 45. $ 5,053 2,651 1,044 2,079 lot income 996 958 Grants and contributions 343 499 Other 731 1,566 $13,356 $13,850 562 Part VI • Financial Analysis 13. Concentration of Credit Risk Significant concentrations of patients accounts receivable include .0 percent and 37 percent from government-related programs, 6 percent and H percent from Empire Blue Cross and I31ue Shield, and 27 percent and 23 percent from Cambridge I Iealth Plans at December 31, 201tl and 2013, respectively. At December .:31, 201'1, 9'> percent of the Medical Center's cash and cash equivalents balance was held at one financial institution. 14. Fair Value of Financial Instruments
- 46. The following methods and assumptions were used by the Medical Center in estimating its fair value disclosures for financial instruments: The carrying amount reported in the statements of financial position for cash and cash equivalents approximates its fair value. Short-term investments consist primarily of government and other debt securities. Fair values are based on quoted market prices. Long-term investments consist primarily of money market funds. Fair values are based on quoted market prices. Assets limited as to use consist primarily of government securities. Fair values are based on quoted market prices. Most of the long-term debt of the Medical Center was refinanced during 2006. The canying value of the Medical Center's long-term debt at December :31, 201'1, approxi- mates it<; fair value. 15. Contingencies The Medical Center is a defendant in various legal actions ansrng out of the normal course of its operations, the final outcome of which cannot presently be determined. The amounts claimed would be material to the financial position of the Medical Center. Medical Center management is of the opinion that ultimate liability, if any, with respect to all of these matters will not have a material adverse effect on the Medical Center's financial position. Approximately 67 percent of the Medical Center's employees are members of vari- ous unions. Of these employees, approximately 70 percent are covered by contracts expiring during 201'5. Suggested Readings Emery, Douglas R., john D. Finnerty, and John D. Stowe. Corporate Financial Mana emenl, ,ird ed. Upper Saddle
- 47. River, N.J.: Prentice Hall, 2007. Finkler, Steven A. Finance & Accountin for Nonjlnancial Managers, .3rd ed. New York, N.Y.: Aspen Publishers, 2003. Fraser, Lyn M., and Aileen Ormiston. Unden;tmulinR Financial Statemellls. 9th ed. Upper Saddle River, 1'.j.: Prentice Hall, 2009. lngcnix St. Anthony. 'IZ1e 2008Aimanac c>/llospital Filial/Cia/ ('.Operating I11dicators. United States: lngenix, 200H. Rcvsinc, Lawrence, Daniel W. Collins. W. Bruce Johnson, and Fred Mittelstaedt. Fil/(mcia/ Reporting ('. Ana vsis, 5th ed. 'ew York: McGra I!ill Irwin, 20 II. Werner, Michael L., and Kumen II. jones. 111/roduction to Financial Accounting: A User Perspectil'£', jrd ed. 'ppt:r Saddle Rin:r, N.J.: l'renricc Hall, 200 1.